Stocks and Commodities Split Ways

Commodity prices softened in the first quarter of 2013, while equity markets surged. The Dow Jones-UBS Commodity Index fell 1.1% from January 1 through March 28—the worst first-quarter showing since 2010.

"The relationship between commodities and equities is more random now than it was from 2008 to early 2012," says Bill Lapp, founder of Advanced Economic Solutions, Omaha, Neb. "Some of the fervor about commodities has left, and the supply and demand fundamentals of individual commodities seems to be holding more influence than they have for some time."

Studies have shown that prior to the global financial crisis, there was a long period when commodity and stocks generally moved in opposite directions. Starting with the global financial crisis, however, commodities and equities have pretty much moved in tandem—until recently that is. According to a recent Wall Street Journal article, the correlation between the S&P 500 and the Dow Jones UBS commodities index has fallen to its lowest level since October 2009.

So why are commodities as a sector losing value? Some analysts argue that supplies of some commodities have rebuilt to levels high enough to create downward pressure on prices, while others say persistent low inflation has taken the urgency out of making speculative investments in commodities. Others say the drop is long overdue.

"This would have happened last year, except for the drought," says Peter Georgantones, analyst with Abbott Futures, Minneapolis. "It’s just a coincidence that commodity prices are dropping while the stock market is going up. Grain prices are falling because we have been losing the demand base."

World wheat production is expected to be record high this year, thus livestock producers will be feeding wheat for a long time, says Georgantones. With wheat at $7.70, corn at $6.40, and soybeans at $14, prices are likely still overvalued, he says. "Wheat will be an anchor on corn prices, and rice will be an anchor on both wheat and corn prices," he adds.

The Federal Reserve’s recent bond buying programs, called quantitative easing, which began shortly after the 2008 global financial crisis, sparked a spate of buying in commodities markets as investors worried that the bank’s injection of money into the economy would ignite inflation. With inflation expected to remain low, the inflation hedge no longer seems as urgent.

"Funds were long corn coming into the recent plantings and stocks reports," says Georgantones. "It’s been a real bloodbath. The fundamentals are washing the funds out." However, he says that inflation remains a real threat.

Commodities have had an incredible bull run over the past eight years. The last time commodities surged to a new higher, plateau was in the early 1970s, says Lapp. That period was followed by a good deal of price volatility. "That may happen again, but there is nothing to suggest we are going back to $2 corn and $6 soybeans, but we may be at the point where we can define what’s too cheap and what’s too expensive," Lapp says.

If supplies of corn and soybeans build, prices will move mostly independent of outside markets. "Producers would be wise to follow the signals their market is giving as to its own fundamentals rather than any outside influence," says Lapp. "Today crude oil is at $95 and nearby corn is at $6.50. Whether crude is at $75 or $115 at harvest, if we have a good corn crop, we will have much lower prices."

Georgantones agrees, saying December corn futures could drop to $4.25 with a huge crop and new-crop soybeans could fall to $10 per bushel.